Storms suspend China's fight against inflation

MomingZhou

SAN FRANCISCO (MarketWatch) -- China's efforts to rein in rampant inflation took a step backward this week after the central bank made an emergency effort to soften the economic pain caused by ongoing brutal snowstorms.

The People's Bank of China issued an order Thursday instructing local commercial banks to speed up loans in areas hit by the deadly blizzards. The action amounts to a suspension of the central bank's efforts to tighten credit in the face of the hottest inflation in 11 years, analysts said.

"[The order] effectively announced that the credit tightening since end-October 2007 is temporarily over for many sectors," said Merrill Lynch economist Ting Lu in a report. It "makes it very clear that the most important task for the PBoC for now is to guarantee the normal functioning of the economy."

The worst snowstorms to hit the country in half a century have made economic stability the top mandate for the bank, even as inflation pressures mount. Ice and snow have ground the country's transportation system to a halt, cut off coal supplies to electric plants, stranded millions of travelers and halted food shipments.

The storms have caused "a very serious hiccup in China's manufacturing engine," said David Riedel of overseas-stock specialist Riedel Research Group. "It's sort of like a Hurricane Katrina situation for them."

At the same time, damage caused by the storms stand to stoke already high inflation. Aluminum prices rallied earlier this week as investors bet China, the world's largest aluminum producer, would smelt less of the industrial metal than previously forecast. Coal prices, the key source of China's electric generation, have also shot up. Analysts anticipate the storms could also encourage China to spend more money on infrastructure, potentially providing a further boost to global commodities prices.

China's high-flying stock market bears the marks of the country's recent economic worries. China's Shanghai Composite Index dropped for three consecutive days and tumbled to as low as 4,195.75 on Friday, or nearly 2,000 points lower than its October peak. The index hasn't seen such a low level since July.

Bad weather started on Jan. 10 and has hit 16 out of 32 provinces. The government so far estimated $7.5 billion in damages, but the real number will be "much bigger than that after the final tally" as snow continues to fall and more blizzards are expected, said Win Thin, an analyst at Brown Brothers Harriman & Co., an investment bank.

Emergency order

For several months China has been trying to restrict credit to fight inflation, which reached 4.8% last year. But the central bank is unlikely to hike rates around next week's Chinese New Year, despite a possible spike of inflation in January, as it keeps its focus on getting the country back on more stable economic ground, said Merrill's Lu.

In a statement released Thursday on its Web site, the central bank ordered all financial institutions to arrange lending guidelines for the first quarter "as soon as possible, to ensure the timely release of loans to qualified borrowers."

The bank also instructed its own branches to use their discount windows to guarantee sufficient credit supplies to areas hit by the storms. The bank said it will earmark 5 billion yuan ($700 million) for agriculture, which was most severely hit by the bad weather.

Commercial banks, meanwhile, were ordered to remove limits on loans for agriculture, energy and infrastructure, and guarantee loans for post-crisis reconstruction, the central bank said.

Storms fan Inflation

The central bank is playing a tricky game of trying to keep the country on its fast-growing path while keeping the lid on consumer price growth. The storms could push inflation to a near-term high of 7.2% in January and 5% to 6% in the first half of the year, said Minggao Shen, an economist at Citigroup, in a research note.

Already, consumers have seen meat prices, which rose sharply last year, leap even further. Zhu Jianguo, who resides in the eastern Zhejiang province, said pork prices at the nearby market jumped more than 20% since the storms began.

"[Prices] went so high that I haven't eaten meat for two days," said Zhu in a phone interview. "But the New Year holiday is coming and we have to buy meat to treat our guests."

The price increases are creating unwanted penny-pinching among the 1.3 billion Chinese preparing to celebrate next week's Lunar New Year. The holiday is the biggest gathering of the year, marked by family get-togethers and large dinner parties. Home cooks are finding the price of vegetables, fruits, and cooking oil has shot up after snows shut down transportation links and closed production facilities.

Worse than rising prices, New Year's revelers could face a power outage during their dinner party.

China's local media reported that more than 17 provinces had to restrict their use of electricity in the past few weeks as a result of a power shortage caused by icy rain, increasing demand due to the cold weather, and the short supply of coal.

More than 80% of power generation comes from burning coal, government data showed.

More demand for commodities

Despite years of strong government investment, recent disarray brought by the snowstorms suggests that underinvestment, not overinvestment, remains China's key challenge, said Merrill's Lu.

Investment accounts for about 40% of China's GDP. China has been trying to lead the country into a consumption-driven economy, but recent storms may force the government spend more money on infrastructure. As a result, the world could see prices of commodities move even higher.

"The snowstorms highlighted the need for them to modernize their railway system and other infrastructures," said Riedel of Riedel Research Group. This need "means more demand for steel, iron ore, and coal for power generation. China can again trigger tremendous demand for commodities."

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